Incisive commentary from leading voices in the world of compliance

For the 200 police involved in the operation in a remote part of Shaanxi province, central China, it must have been one of their more memorable and unusual jobs: investigating, raiding and closing down an anonymous warehouse full of powerful computers mining Bitcoin using stolen electricity.

But this scenario could soon be more commonplace if recent developments are a guide.

All Bitcoin miners may well find their activities in China curtailed as the authorities look to crackdown on an industry that has grown rapidly in China and is using ever growing volumes of electricity.

Last week confusion reigned as various conflicting reports emerged with some claiming a committee of the People’s Bank of China PBOC (the Central Bank and financial regulator) held a secret meeting in which it was agreed that Bitcoin mining would be shut down.

Later reports declared this false, (which made sense as the PBOC does not have oversight of the power supply), but indicated instead that local authorities should not give preferential treatment to Bitcoin miners.

Further reports have since surfaced which indicate that the Chinese internet finance regulator, namely the Leading Group of Internet Financial Risks Remediation, has requested local governments to “make an orderly exit” from supporting Bitcoin mining.

The memo reportedly issued to all local offices of the internet regulator went on to request that regional governments use measures around land use, electricity price and the environment to ensure that Bitcoin miners are driven out of business.

In addition, it is understood that the regulator requested progress reports every month, possibly to try and ensure action is taken.

Of course there is no guarantee that the order will work, local power suppliers may still cut deals on side to get a slice of lucrative mining action, but if it does work then the days of China dominating Bitcoin mining could be over.

The PBOC has already banned public Bitcoin exchanges in China and initial coin offerings last year, though this has just shifted demand to the so-called over the counter, or peer to peer market.

This is much harder to regulate or even ban, but until now mining has been an untouched industry.

Bitcoin mining has garnered increasing attention not only because of its rapidly rising value but also thanks to the amount of energy which is required to create new Bitcoin.

Estimates calculated by Digiconomist put the total energy used in worldwide Bitcoin mining on par with that of Ireland and ahead of most African states.

For the casual observer this is perhaps a bewildering concept and to understand a brief primer on Bitcoin is necessary.

Bitcoin mining is modern day alchemy, effectively turning power into money via powerful computers.

Creating a new Bitcoin is a bit like winning the lottery, in order to win the miner must find a hash which starts with a sequence of zeros, this is determined by raw computing power and vast amounts of energy, when a winning hash is created new Bitcoins are created and added to the blockchain.

The more hashes that can be created relative to other miners will determine how many Bitcoin are created, this has led to a brutal race between miners to invest more and more in computing power to get ahead of the competition all of which require significant amounts of power.

China’s massive industrial base requires a regular supply of cheap energy, which is primarily supplied by dirty, inexpensive coal plants and huge hydroelectric projects like the Three Gorges Dam.

All this did not go unnoticed by many entrepreneurs who saw an opportunity to turn this cheap power into money and so Bitcoin mining increasingly shifted to China.

The Central and Western regions in China like Gansu, Inner Mongolia and Sichuan have access to the cheapest energy in China, subsidised in order to help attract manufacturing plants to its less developed regions.

In addition many Bitcoin miners have cut deals with local power stations to enjoy even cheaper energy.

This might sound strange, but the inefficiencies of the Chinese electric grid means that there are times when energy from major sources like dams or coal fired power stations are not fully used and therefore can be easily siphoned off.

Early on there were many different miners, but as competition increased, ever more powerful and expensive computers were required, which demanded vast and increasing amounts of energy.

This cut throat competition and the lure of easy money has led some to resort to stealing electricity to carry out their mining.

Some established Bitcoin miners have even caught their own employees stealing electricity at night to power their own Bitcoin operations.

One mine owner was quoted as saying “I fired three guys 20 days ago because I caught them stealing electricity to mine bitcoin for themselves. It is a public secret among workers. They always do this at midnight to escape attention”.

Unfortunately there is also an environmental impact to Bitcoin mining, this energy hungry activity is concentrated in areas like Gansu and Inner Mongolia where coal is king in terms of energy production.

For example Bitmain, the world’s biggest supplier of Bitcoin rigs (the computers and equipment required to mine Bitcoin), as well as a major miner in its own right, set up its main mining centre in remote Inner Mongolia in Northern China.

Despite having to pay a lot for cooling costs in the roasting summers of Northern China, it remains one of the cheapest places to mine Bitcoin.

However, China is trying to wean itself off the fossil fuel which is a major contributor to greenhouse gases and of course is a potent ingredient in the toxic soup which envelopes many major Chinese cities.

While the government is keen to curb coal use, it is probably the ideal that Bitcoin represents which is the primary target of the authorities.

Ultimately, it appears the Chinese authorities are less concerned by power usage than they are about bringing the downfall of Bitcoin.

The cryptocurrency is a threat with the potential to undermine traditional currencies, capital controls and taxation systems, none of which are particularly attractive scenarios to the Chinese Communist Party.

This development highlights the fragility and absurdity of Bitcoin mining operations and the power of the Chinese regulators.

If they really do follow through with this crackdown on Bitcoin mining it could push the industry out of the country and dramatically raise the cost of creating new Bitcoins, changing the economics of the cryptocurrency forever.

Merlin Linehan has a background in banking and has written about cross-border international crime and money laundering. He is the founder of Rising Powers, a website covering business and innovation in emerging markets.

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